The following article is adapted and reprinted from the M&A Tax Report, Vol. 11, No. 6, January 2003, Panel Publishers, New York, NY.
LEGISLATIVE INDOPCO REVERSAL?
By Robert W. Wood
As the new year unfolds, it is time to put away the holiday decorations, throw out the leftover eggnog, and hope for a better day. For large corporate taxpayers, there have been few issues over the past few years as nettlesome as the age-old deduct vs. capitalize debate. Memorialized by INDOPCO, Inc. v. Commissioner, 503 U.S. 79 (1992), it cannot be gainsaid that this issue is the real deal.
Some readers may have thought us a touch myopic when we covered the illustriously named "INDOPCO Coalition" paper. Doesn't the INDOPCO Coalition sound a little like the five families? I'm certain there's a Godfather Part IV somehow connected to all this. See Wood, "INDOPCO Coalition Weighs In," Vol. 10, No. 5, M&A Tax Report (Dec. 2001), p. 1. After all, the vast majority of papers presented to Treasury and/or legislative committees either go nowhere or take longer than a Michener novel to bear fruit.
For readers who don't remember, the INDOPCO Coalition has a luminary list of huge corporate members, with plenty of individual notables, such as former IRS Commissioner Fred Goldberg of Skadden Arps at the helm. Basically, the Coalition's massive paper argued that the current law's basic presumption of capitalization should be turned on its head. On the basic presumption of capitalization, the IRS has for some years now wanted to read INDOPCO as saying when in doubt (meaning always), you should capitalize it.
All the "separate asset" or long-term benefits arguments about capitalization may now (at least when these rules are finalized) fall by the wayside. There are a few people (Tax Analysts' Lee Sheppard, for example) who argue that this is more than nefarious. For all corporate taxpayers, though, this will be more than welcome relief. As it appears now, there will be a list of items that will need to be capitalized, but anything falling off of this list will (presumably) be deductible. Whether this is a good idea from a tax policy perspective (something way beyond my ken), it is certainly practical. Taxpayers will be on notice to keep appropriate capitalization records, and will have clear guidance without a lot of murky and imprecise standards.
As an administrative matter, some parts of the IRS have already been using an interim "one year" rule, under which expenditures that are anticipated to have benefits beyond one year would be capitalized, and others not. The IRS has evidently been struggling for some time with the question of whether it should expend resources asking for capitalization of expenditures that have a benefit beyond the end of the tax year in which they are made. One internal memorandum recommends that IRS examiners who have not already raised the capitalization issue in such cases not raise it from that point forward.
The idea is that a one year rule would be easy to administer. Capitalization of an expenditure would not be required unless the benefits created by the expenditure extend beyond twelve months after the first date on which the taxpayer realizes the benefits attributable to the expenditure, or the end of the tax year following the tax year in which the expenditure is incurred. Basically, this one year rule would allow deductions to be accelerated by a year.
M&A Tax Report readers may remember that the INDOPCO Coalition had itself proposed a one year rule. As the coalition formulated it, something that had a useful life of less than twelve months would not be an "asset" within the meaning of the capitalization concept. The administration evidently didn't like that formulation, instead choosing to base its one year rule on a future benefit analysis.
Ultimately, it appears that Treasury is at least working on proposed regulations that would take this kind of approach. In large part, this signals victory for the INDOPCO Coalition. In Celebrity Death Match: IRS vs. INDOPCO Coalition, the latter seems likely to come out on top. For most of us in the trenches, this may end up ameliorating much of what was wrong with the INDOPCO mantra that has been spouted Hari Krishna-like for most of the last ten years. (For an excellent, although critical, examination of this issue largely from the government's perspective, see Sheppard, "INDOPCO Repeal Rolls Forward," Tax Notes (Sept. 9, 2002), p. 1438.)
Legislative INDOPCO Reversal?, Vol. 11, No. 6, The M&A Tax Report (January 2003), p. 7.